Dominion Energy's Dividend Is Not As Safe As You Think

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About: Dominion Energy, Inc. (D)
by: Sure Dividend
Summary

Dominion Energy's high dividend yield and growing dividend history have given the company a well-deserved reputation among dividend growth investors.

With that said, its above-average yield has also led some investors to question the safety of its current dividend payment.

In this article, we examine Dominion Energy's current dividend safety by looking at earnings, free cash flow, recession performance, and debt (including an interest rate stress test).

Dominion Energy (D) is a well-known dividend stock because of its combination of dividend yield and growing dividend history.

With that said, the same yield that has made the company popular among investors has also led some to question the safety of its current dividend payment.

In this article, we examine Dominion Energy's current dividend safety by looking at earnings, free cash flow, recession performance, and debt (including an interest rate stress test). If you prefer learning through videos, you can watch a video analysis on the topic below:

Business Overview

To begin, let's talk about Dominion Energy's business model. Dominion Energy is a large electric utility that is headquartered in Richmond. Dominion Energy is valued at $47 billion and has more than six million customers in eight states. In addition to electricity services, Dominion Energy also operates in some other industries. The company recently started its Cove Point LNG project, for example. Dominion Energy, which was founded in 1983, is headquartered in Richmond, VA.

Dominion Energy is a well-known dividend stock because of its excellent combination of yield and growth. The company currently trades with a dividend yield of 4.6% and has increased its dividend for 9 consecutive years. This means that Dominion Energy is just one year shy of being included in the Dividend Achievers Index, a group of stocks with more than 10 years of consecutive dividend increases.

Looking ahead, Dominion Energy's high dividend yield has led many investors to question the safety of its future dividend payments. For the remainder of this article, we will discuss the company's current dividend safety from four perspectives:

  1. its dividend safety in the context of its current earnings
  2. its dividend safety in the context of its current free cash flow
  3. its dividend safety in the context of its recession performance
  4. its dividend safety in the context of its current debt load

Dominion Energy's Dividend Safety Relative to Earnings

First, let's discuss Dominion Energy's dividend safety in the context of the company's current earnings.

When Dominion Energy reported third quarter financial results on November 1st, the company announced that it generated earnings per share of $1.30 in the three-month reporting period. For context, Dominion Energy paid $0.835 of dividends during the same time period for a payout ratio of just 64%.

Looking out over a longer time horizon, our conclusion is the same. Dominion Energy's most recent financial guidance calls for 2018 earnings per share of $4.02 at the midpoint, and the company is on pace to pay $3.34 of per share dividends during the same time period for a payout ratio of 83%.

Using earnings, Dominion Energy's dividend appears very safe for the foreseeable future.

Dominion Energy's Dividend Safety Relative to Free Cash Flow

Many analysts believe that comparing a company's dividend payments to its free cash flow is a better method for assessing dividend safety. Accordingly, we will now compare Dominion Energy's current dividend payment to its free cash flow.

Through the first nine months of fiscal 2018, Dominion Energy generated $3.7 billion of cash from operating activities and spent $3.1 billion on capital expenditures for free cash flow of around $600 million. The company spent $1.6 billion on common share dividends during the same time period for a free cash flow dividend payout ratio above 100%.

This is an alarming observation. It appears that Dominion Energy made up for this cash shortfall by issuing an additional $1.2 billion of debt (net of repayments). While Dominion Energy's inability to cover its dividend payments with free cash flow may be due to a temporary period of increased investment, we recommend that current and prospective investors monitor this trend closely moving forward.

Dominion Energy's Dividend Safety Relative to Recession Performance

Companies do not cut their dividends in good times. Instead, dividends are reduced when companies experience financial difficulties. Accordingly, this section will analyze Dominion Energy's current dividend safety in the context of the company's historical recession performance.

We believe that the best way to measure a company's recession resiliency is by measuring its earnings per share performance during the financial crisis that occurred between 2007 and 2009. Dominion Energy's performance during this time period is shown here:

  • 2007 adjusted earnings per share: $2.13
  • 2008 adjusted earnings per share: $3.04
  • 2009 adjusted earnings per share: $2.64
  • 2010 adjusted earnings per share: $2.89
  • 2011 adjusted earnings per share: $2.76
  • 2012 adjusted earnings per share: $2.75

Dominion Energy's earnings per share actually increased from their 2007 level through the global financial crisis. Because of this, we have no concerns about the company's ability to pay rising dividends during future economic downturns.

Dominion Energy's Dividend Safety Relative to Its Current Debt Load

The last angle that we will use to assess Dominion Energy's current dividend safety is by looking at the company's current debt level. More specifically, we will see how much the company's weighted average interest rate will need to increase before the company's net income will no longer cover its dividend payment.

Through the first nine months of fiscal 2018, Dominion Energy generated $1.1 billion of interest expense and had $30.2 billion of debt outstanding for a weighted average interest rate of 4.9%.

The following image shows how changes to Dominion Energy's weighted average interest rate would impact the company's dividend coverage, as measured by free cash flow.

D Dominion Energy Interest Rate Stress Test

Source: Sure Dividend Calculations

As the image shows, Dominion Energy's weighted average interest rate would only need to rise to approximately the 6% level before its dividend would no longer be covered by net income. This is a much smaller margin of safety than what is common among the other stocks we've investigated in this dividend safety analysis series. It is particularly troubling when combined with our earlier observation that Dominion Energy's free cash flow has not recently covered its dividend. With that in mind, we recommend that any current or prospective investors in Dominion Energy monitor its future financial performance closely to avoid experiencing a dividend cut.

Final Thoughts

Dominion Energy's high dividend yield has led some investors to question the safety of its current dividend payment.

In this article, we examined Dominion Energy's dividend safety relative to earnings, free cash flow, recession performance, and debt. Unfortunately, there are a number of red flags concerning Dominion Energy's dividend safety - its interest coverage is poor and its dividend has not recently been covered by its free cash flow.

Because of this, we recommend that investors monitor Dominion Energy's dividend safety closely. It may not be as safe as you think.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.